A shares still fall short of a good buy

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As PE ratios dip, it might be worthwhile switching out of government bonds and yuan bank deposits

After the government more than doubled their A share quota to US$10 billion from US$4 billion, some foreign investors are wondering whether it is time to bottom-fish in China's battered stock market.

To determine whether an A share is cheap enough, the manager - holding a quota given to a qualified foreign institutional investor (QFII) - must look at the price of its comparative H share, denominated in Hong Kong dollars, in Hong Kong. There are 28 Chinese firms with shares listed in both markets. Since their listing, H shares have always been cheaper and, most would say, more accurately priced.

It is understandable to see why foreign investors have opted for H over A. The A-share price, up to five to six times higher, has been artificially supported by state policy and state-linked shareholders.

But the differential is narrowing fast, thanks to the continuing fall of the A-share market. The average price-earnings ratio in the Shanghai market used to be 30-40 times, double that in Hong Kong. Now it has fallen to about 16, while Hong Kong is about 10.7 times.

Has the moment finally come for QFIIs to sell H shares and buy A shares instead? Judging from their investment so far, the answer is 'not yet'. Much of the QFII money has gone into government bonds and yuan bank deposits, betting on a revaluation, and only a portion into the A-share market.

As of the end of March, QFIIs had invested 4.48 billion yuan in A shares, less than 0.5 per cent of total market capitalisation and less than 10 per cent of their quota.

Foreign investors are cautious for the same reason as domestic ones - a falling market, lack of transparency, poor corporate governance, expectation of poor earnings this year and the flood of new paper that will come with the disposal of state shares.

Uncertainty still clouds this plan to make tradable the state shares of the 1,400 listed companies. Some believe it will be abandoned or postponed.

So H shares and other Chinese counters issued outside the mainland will remain the preferred option for foreign investors for now.

But the institutions are delighted to have additional quota, because demand for China investment is so strong and they want to have the money on hand when and if the market finally turns up.

Citigroup has applied to raise its US$400 million quota. So has Credit Suisse First Boston, which has US$150 million.

The 'queen' of QFII is Nicole Yuan, head of Chinese securities at UBS and the most vocal advocate of a larger quota and more liberal terms for foreign investors. UBS was the first foreign firm given a quota by the CSRC in May 2003, which it invested in Baoshan Steel, Shanghai Port Container, Sinotrans Air and ZTE Corp.

Of its investment, 60 per cent has gone into A shares, 20 per cent to 30 per cent into debt instruments and 10 per cent into funds, a much bigger vote of confidence in A shares than their QFII peers. Ms Yuen said UBS had almost exhausted its quota of US$400 million.

Demand from clients was so heavy it had asked the authorities for an additional US$300 million to US$500 million.

Foreign investors go after the same group of better-managed A-share firms.

A study by Gu Canqi, deputy general manager of Meilian Finance Investment Consultancy, found that, at the end of October last year, QFIIs held 211 million A shares in 31 firms, with the 10 most popular being Zhongxing Telecom, Yangtze Electric Power, Baoshan Steel, Yanjing Beer, Shanghai Container, Fuyao Glass, Yantian Port, New Steel & Vanadium, Sinotrans Air and Zhongkin Gold.

He found that QFIIs held 12.71 per cent of the A shares of Zhongxing Telecom and 11.57 per cent of Yanjing Beer's, the highest proportions in any big firm.